Definition
ArbitrageArbitrage is the attempt to profit from small price differences in the same asset, or equivalent combinations of assets, by buying and selling at once.
Example
If EUR/USD × USD/JPY implied a EUR/JPY rate of 163.00 while EUR/JPY itself was quoted at 163.20, a triangular arbitrage would sell EUR/JPY and buy the two legs, locking in the gap before costs.
In detail
In theory, arbitrage is risk-free profit: if the same thing trades at two prices, you buy the cheap one and sell the expensive one simultaneously. In forex, the most common textbook version is triangular arbitrage, which uses three currencies.
Every cross currency pair has an "implied" rate built from two dollar pairs. For example:
Implied EUR/JPY = EUR/USD × USD/JPY
If the quoted cross drifts away from the implied rate, an arbitrageur trades all three legs to capture the difference.
Example
Assume (illustratively) EUR/USD = 1.0800 and USD/JPY = 150.00. The implied EUR/JPY rate is 1.0800 × 150.00 = 162.00. If a dealer quoted EUR/JPY at 162.30, the cross would be 30 pips "rich." A trader could sell EUR/JPY, buy EUR/USD and sell JPY for USD (buy USD/JPY), so the three positions offset each other in currency terms while leaving the 30-pip difference as gross profit.
Why it rarely works for retail traders
Real markets close these gaps in milliseconds. Banks and high-frequency firms run automated systems that monitor thousands of quotes, and the moment a mispricing appears it is traded away. For an individual trader, several frictions eat any apparent edge:
- Each leg pays a spread, so three spreads must be covered.
- Slippage and delayed execution mean the prices may be gone before all legs fill.
- Price feeds at retail brokers may lag slightly, so a "gap" can be an illusion.
Some brokers also prohibit strategies designed to exploit stale prices ("latency arbitrage") in their terms of business.
Why it matters
Even if you never attempt it, arbitrage explains why currency prices stay consistent across venues and why cross rates track their dollar legs so closely. It is one of the forces that keeps the market efficient.
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Related terms
- Cross Currency PairA cross currency pair, or cross, is a pair that does not include the US dollar, such as EUR/GBP, GBP/JPY or AUD/NZD.
- SpreadThe spread is the difference between the ask (buy) price and the bid (sell) price of a currency pair. It is a built-in cost paid on every trade.
- ExecutionExecution is the process of filling a trade order: the price, speed and method by which your buy or sell instruction becomes an open or closed position.
- LiquidityLiquidity is how easily a currency pair can be traded in size without moving its price much. High liquidity usually means tighter spreads and smoother fills.